The Traps of Equity Release on Rented Properties

Jonathan-Hook-Norwich-Accountancy-ServicesIn order to achieve greater ‘revenue relief’, many landlords release equity from their properties using the money in whichever way they choose – for example if they decide to buy a Ferrari or go on a world trip with the proceeds they can! …. and provided that the amount borrowed is not greater than the market value of the property when it was first let the interest will be tax deductible! Sound too good to be true? –  well it isn’t – but there can be a few traps to look out for:

The trap for many landlords who wish to sell their properties is that they don’t keep tab of this original market value when they remortgage, borrowing well in excess of this amount not realising that the excess is not tax deductible.

A simple real life example will help to illustrate this: 

Charlotte inherits a cottage with a probate value of £200,000 and proceeds to release equity from it to finance private expenditure. 10 years later the property is worth £300,000 yet she had released £250,000 in equity (£50,000 in excess of the original market value when she first inherited it, assuming she let it straight away). The problem Charlotte now finds is that the interest that is tax deductible is now ‘capped’ yet at the same time the rental income which she receives is presumably increasing causing her to pay more income tax (assuming a positive net rental income).

Other than the ‘disallowed interest trap’ the other trap is known as the CGT trap. Following the example above, Charlotte holds the property for another 10 years by which time it is worth £400,000. She has now leveraged up to £350,000 due to more private expenditure (including a new Porsche) but now wants to sell and move abroad. She goes to sell and gets £390,000 leaving her with £20,000 after paying off the mortgage and legal & agent fees of £20,000. Her problem now is that after allowing for her annual exempt amount of £10,900, CGT is payable at 28% (assuming she’s a higher rate taxpayer) on £159,100 – tax due of £44,548! She now has to sell the Porsche to pay the taxes. Not only this but she’s been doing her own tax returns and HMRC have just discovered that she has been over claiming interest on the rental property for several years. Bottom line? – talk to your accountant.. But then I would say that wouldn’t I…?

Jonathan